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Firm Seeks Changes to FDII, GILTI Regs

NOV. 4, 2019

Firm Seeks Changes to FDII, GILTI Regs

DATED NOV. 4, 2019
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November 4, 2019

The Honorable David J. Kautter
Assistant Secretary
Office of Tax Policy
U.S. Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

Chip Harter
Deputy Assistant Secretary
International Tax Affairs
Office of Tax Policy
U.S. Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

Dear Sirs:

I am writing to comment on the Section 250 proposed regulations (Internal Revenue Service REG-104464-18 — Deduction for Foreign-Derived Intangible Income and Global Intangible Low-Taxes Income) (the "Proposed Regulations") as they apply to certain types of sales of property to foreign persons through intermediary U.S. entities.

For various business reasons including historic relationships with unrelated parties and efficiencies from entering into global deals to sell property to unrelated parties, U.S. companies may arrange to sell products they manufacture to another U.S. entity even though such property immediately is resold to a foreign person, shipped directly abroad and used by the foreign purchaser outside the United States. In such arrangements, the U.S. intermediary never takes possession of the property, but merely facilitates the sale. Similar global deals may occur in the licensing context where contingent royalties may be based on foreign income and accounting to the licensor by country is required.1

Income from these sales may not qualify as foreign-derived deduction eligible income (“FDDEI”) because the intermediary is a U.S. person. In substance, however, if that U.S. intermediary recognizes no or de minimis income from its purchase and resale (or license and sublicense), the taxpayer should be viewed as selling (or licensing) to the foreign person and the U.S. intermediary as earning a service fee, with the result that the taxpayer would be eligible for foreign-derived intangible income (“FDII”) benefits on its income from the sale (or license) of its products.

I recognize that section 250(b)(4) requires property to be both "sold by the taxpayer to any person who is not a United States person" and "for a foreign use" to be eligible for the FDII deduction. Although the first requirement could be read to preclude any sale to any U.S. person, the drafters of the statute appear to have contemplated situations where sales to a U.S. intermediary could be treated as sales to a non-U.S. person. In particular, in defining "foreign use," Congress added an explicit provision with the heading "Property or Services Provided to Domestic Intermediaries" that prevents taxpayers from meeting the requirements of foreign use where a domestic intermediary further manufactures or otherwise modifies the exported property within the United States (section 250(b)(5)(B)). Given that "domestic intermediaries" normally refers to domestic entities, that provision would be unnecessary if no sale to a domestic intermediary entity could qualify for FDII benefits. Its existence is an indication of Congressional intent to allow certain domestic intermediary transactions to qualify for FDII benefits.

Moreover, the Proposed Regulations provide that certain sales through domestic intermediaries can qualify as FDDEI transactions. Proposed Regulation section 1.250(b)-3(c) specifies that military sales of property to the U.S. government for resale to a foreign government will be treated as sales to that foreign government if the contract between the taxpayer and the U.S. government expressly provides that the property is purchased for resale to such foreign government. The commercial arrangement described in this letter is directly analogous to the foreign military sales situation. The preamble notes that the Treasury Department and IRS considered allowing the seller to qualify in this commercial situation, but were concerned that the U.S. seller and the intermediary might both claim FDII benefits on the transaction. However, if the intermediary earns no margin on the product sale, only the U.S. seller and not the intermediary potentially would have FDDEI.

Although the preamble to the Proposed Regulation does not provide an explanation, presumably the Treasury Department and IRS included the treatment of foreign military sales by exercising their authority under section 250(c) to "prescribe such regulations . . . as may be . . . appropriate to carry out the provisions of this section." Under other Code provisions, that authority has been interpreted to provide the Treasury Department and IRS broad authority to write regulations that further the goals of the statute. See, e.g., Schwalbach v. Commissioner, 111 T.C. 215 (1998) and Chamber of Commerce of U.S.A. v. IRS, 120 AFTR 2d 2017-5967 (W.D. Tex. Oct. 6, 2017).

I believe the Treasury Department should exercise that same authority to treat commercial transactions as sales to foreign persons where the sales are through the kind of "domestic intermediary" implicitly contemplated by section 250(b)(5)(B). Thus, a new subsection could be added after Proposed Regulation section 1.250(b)-3(c) as section 1.250(b)-3(d) (with the later sections renumbered accordingly) as follows:

(d) Commercial Sales Through Domestic Intermediary. For purposes of determining whether a sale of property through a domestic intermediary to a foreign person is a FDDEI transaction, if: (i) resale to the foreign person occurs contemporaneously with the sale to the intermediary (i.e., the sale is a "flash title" sale); (ii) the property is shipped directly from the taxpayer to the foreign person; and (iii) the domestic intermediary earns no return or only a de minimis return (no more than one percent of the sale price) on the sale transaction, then the sale of property is treated as a sale to the foreign purchaser.2

Given that taxpayers may not be able to obtain information from unrelated intermediaries necessary to demonstrate compliance with conditions (i) and (iii) above, an alternate subsection that similarly addresses the Treasury Department and IRS concerns about multiple claims to FDII benefits could be considered. In particular, an alternate subsection could be added as follows:

(d) Commercial Sales Through Domestic Intermediary. For purposes of determining whether a sale of property through a domestic intermediary to a foreign person is a FDDEI transaction, if: (i) to the taxpayer’s knowledge, resale to the foreign person occurs contemporaneously with the sale to the intermediary (i.e., the sale is a "flash title" sale) and (ii) the property is shipped directly from the taxpayer to the foreign person, then the sale of property is treated as a sale to the foreign purchaser. In such transaction, the domestic intermediary shall not treat the sale of property as a FDDEI transaction.

To address the licensing arrangements, Treasury should treat transactions as sales to foreign persons if the taxpayer licenses property to a United States person and explicitly grants that person the authority to sub-license the property to the licensee’s foreign affiliates and the taxpayer’s compensation under the contract reflects a component for foreign use or the taxpayer’s books and records reflect compensation for foreign use.

Such a provision would give substance to the section 250(b)(5)(B) domestic intermediary exclusion contemplated by Congress in drafting the statute and thus clearly would be within Treasury and IRS’s broad authority to adopt regulations "necessary or appropriate to carry out the provisions of this section" under section 250(c). It would also provide equitable treatment between foreign military sales and foreign commercial sales that otherwise are very similar in structure and substance.

I would be pleased to discuss this issue further with your staffs at their convenience. If you have any questions, please contact me at 202-772-2482 or ken.kies@fpgdc.com.

Sincerely,

Kenneth J. Kies
Federal Policy Group
Washington, DC

FOOTNOTES

1 In theory, taxpayers could obtain the section 250 deduction by requiring the U.S. intermediary to form a foreign partnership through which the property is sold or licensed. Such a step would convert ineligible income into FDDEI without changing the substance of the transactions. Regardless, a regulatory solution would eliminate the opportunity for the relevant foreign party to extract economic concessions from the sellers in exchange for agreeing to a purchase through the foreign partnership.

2 A fourth requirement that the sale meets the requirements of section 250(b)(5)(B) could be added, but that inclusion seems unnecessary given the requirement that the property be shipped directly from the taxpayer to the foreign person.

END FOOTNOTES

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